Imagine that you’re living in rural India, and there is a lockdown because of COVID. You realize you need cash. Yes, banks are open but there are no bank branches close by, the nearest ATM is more than 40 km away. Travelling large distances becomes extremely risky because of the lockdown. How do you cope? How do you withdraw money? Well, there is a simple solution. You go to your nearest kirana shop, or to a ‘banking correspondent’, give the shopkeeper or the ‘agent’ your Aadhar number and the name of your bank, put your finger onto a fingerprint reader, and lo and behold, your account is debited, and the bank correspondent gives you cash.
What if you had no money in your account? Luckily, your daughter works in the city and has some money to give you, but how does she send it to you? She is under lockdown too. Don’t worry, she logs onto Google Pay or PayTM, and sends you money instantaneously from any of her bank accounts to your bank account. She does not even need to remember your bank account number. You could share an alias (called a virtual ID) with her which could be something similar to an email address – alkesh@sbi for instance, and she transfers money using this ID. A decade ago, sending money often meant doing a postal transfer that took days and cost ~5-10% of the transfer value. Today it is instantaneous and free.
In the first case, the system used to withdraw money is called the Aadhar Enabled Payment System (AePS) and in the second case, it is the much-vaunted United Payments Interface (UPI).
As a result of systems like AePS and UPI, financial flows during the lockdown were made much easier. To give you an idea of the scale of transactions, money transfers through UPI now average about 2 billion transactions every month, up from approximately 700 million monthly transactions from a year ago. This is more than all the credit and debit card transactions in the country!
How has all this become possible? It hasn’t been the private players who’ve built these systems. Unlike in the West, where private players like Mastercard and Visa have built platforms that allow you to access your money from any ATM or pay any merchant, in India the government took a series of steps and set up different types of public goods, which are nearly free, to enable financial inclusion.
This included important steps like encouraging banks to open bank accounts for every citizen and encouraging bank correspondents allowing cash withdrawals and deposits to be made outside bank branches. These initiatives have led to more accessible banking, especially in rural areas.
There have been further innovations like the creation of a digital identity (99% of Indians have Aadhar numbers) that allows you to use your fingerprint to withdraw cash and the development of UPI, a public switching system that allows you to instantly send money from any bank account of yours to anyone else’s bank account. In the case of UPI, you might feel that such an innovation would be largely under the ambit of private technology players like Google Pay or PayTM. But no, they have only built the front-end applications that customers see. At the back end, a government-sponsored system built by the National Payments Corporation of India (NPCI) does all the hard work of actually transferring the money. An initiative of the Reserve Bank of India (RBI) and Indian Banks’ Association (IBA), NPCI is an umbrella organization that operates retail payments and settlement systems in India.
We take you through the journey of how the government enabled all this and the unfinished agenda of financial inclusion in India.
Banking on the Excluded: The progress of financial inclusion in India
At a fundamental level, financial inclusion means that individuals and businesses have access to useful and affordable financial products and services that meet their needs (these could be transactions, payments, savings, credit, and insurance) and are delivered in a responsible and sustainable way. In an Indian context, having access to a savings account is often the first step toward broader financial inclusion since it serves as a transaction account, allowing people to store money, and send and receive payments. This account acts as a gateway to other financial services, which is why ensuring access to savings accounts has been a key focus in most financial inclusion initiatives in the country.
India’s Journey towards Inclusive Financial Services
Inclusive banking in India can perhaps be traced to the waves of nationalization of banks which began in the late 1960s and continued over the next two decades. While the focus at the time was credit delivery, initiatives like the lead bank scheme, the establishment of regional rural banks and priority sector lending played their part in extending formal financial services. However, the concentrated focus on financial inclusion as we know it today emerged in 2005 when the Reserve Bank of India (RBI) highlighted the significance of the term in its annual policy statement. It recognized concerns that the banking sector at the time may have become exclusionary in nature and urged banks to work towards reaching out to the masses, offer banking services in rural frontiers and incorporate financial inclusion into their existing business practices. All banks were advised to offer a basic banking ‘no-frills’ account either with ‘zero’ or very low minimum balances as well as low or negligible operational charges that would make such accounts accessible to vast sections of the population.
Simultaneously, while highlighting the need for increased account ownership, the problem of last-mile access to banking services was also a key issue that needed to be solved. Most rural areas lacked traditional brick and mortar banking establishments and needed a differentiated delivery mode. In 2006, the RBI introduced the business correspondent model that we alluded to earlier. This would become a cornerstone of the country’s financial inclusion drive. It allowed banks to have third-party, non-bank agents (known as Business Correspondent Agents or BC agents) that could extend their services right to the customers’ local communities. This meant that entities like grocery stores, petrol stations, telecom providers and other companies with retail networks could perform financial operations on behalf of banks. These operations could include opening and maintaining accounts, sourcing small value loan proposals, and providing other basic services.
Changing the Financial Inclusion Narrative
While these developments set the course for financial inclusion in the country, the real fillip came with the introduction of India’s flagship financial inclusion program – the Pradhan Mantri Jan Dhan Yojana (PMJDY). Launched in 2014, the program sought to provide a basic ‘jan dhan’ account to every adult, with simpler documentation requirements and ‘Know Your Customer’ norms. It leveraged the existing BC agent network and significantly changed banking demographics in the country, sharply narrowing gender gaps in financial access. According to the World Bank’s Global Findex report (2017) 80% of Indian adults had a bank account (compared to 53% estimated in 2014) and 77% of Indian women-owned a bank account (against 43% in 2014). As of November 2020, 412 million jan dhan accounts have been opened.
One of the primary reasons for the success of the program was the close involvement of the government in implementation and its execution in ‘mission’ mode. The prime minister’s office remained active in monitoring its progress and banks were held accountable to strict deadlines in terms of account opening targets, crucial facets that had been missing from earlier financial inclusion initiatives. It is also important to note that previous attempts to open accounts as part of inclusion drives were hampered by the fact that banks offered accounts with limited functionality. There had been caps on maximum account balances, ATM cards were not issued, cheque deposits were not permitted, and customers were only allowed to transact at BC agents but not at branches. The jan dhan accounts offered customers the functionalities of full-service accounts which further increased demand.
Jan dhan accounts have now become ubiquitous and are an essential part of the ‘JAM’ trinity- an initiative to link the jan dhan accounts, Aadhar numbers and mobile numbers that has helped monitor the quality and reach of services to the poor allowing the seamless delivery of government benefits and transfers directly into beneficiary accounts. Further innovations in transaction systems by NPCI, notably AePS, have also made it simpler and more secure for customers to access formal financial services.
COVID 19 and the Renewed Importance of Financial Inclusion Infrastructure
As other developing countries struggled to transfer benefits to citizens during the pandemic, India was much better positioned because of the earlier investments in financial inclusion infrastructure. The government was able to use the existing jan dhan accounts to transfer cash benefits into the accounts of more than 200 million women and other beneficiaries.
During the countrywide lockdown, BC agents were classified as essential services and could operate when most other business establishments were shut, allowing customers to access their accounts and make crucial withdrawals. Digital transactions surged, led by AePS based withdrawals which emerged as a critical cash-out medium for low-income families who received G2P payments and benefits into their accounts. It is striking that NPCI processed 290 million transactions through AePS from April to June 2020 worth INR 528.21 billion – an increase of ~151% in volume and ~61% in value compared to the transactions during the first quarter of the calendar year. NPCI has also indicated the potential roll-out of Aadhar linked iris and face recognition enabled payments in a measure to make AePS contactless. If implemented, this could be a further driver of acceptability and usage especially in the wake of COVID 19.
While the pandemic adversely affected many core sectors, it has catalyzed a definite shift in financial inclusion efforts from a demand perspective. Interestingly, 30 million new jan dhan accounts have been opened since April 2020 (far higher than the 19 million new accounts opened during the same period last year). This surge could partially be attributed to the greater thrust on digital payments – with the rising fear of infections – as well as the slew of government-provided benefits.
Looking Ahead: A Winding but Paved Road
Though India’s financial inclusion advances have been considerable, there is still some way to go before they can be absolute. Progress on account ownership is tempered by the fact that about 48% of bank accounts have seen no transactions in the last year, and that India has the world’s highest share of inactive accounts (about twice the average of 25% for comparative developing economies). Jan dhan account holders also have access to subsidized insurance and pension schemes, but these have not seen high uptake.
From a supply perspective, the BC model has been hampered by operational hurdles and sustainability issues from a business viability point of view. These are particularly relevant in rural areas where the lack of customer footfall and lower awareness among potential customers make individual BC agents unviable. This leads to high levels of agent dormancy and attrition which further dampen financial inclusion efforts.
Key actors in the financial inclusion space have taken note of these issues. Banks are now looking to make the agent model more sustainable. They have undertaken efforts to diversify and expand the portfolio of products sold by agents. The RBI has announced that it plans to assess the impact of the pandemic on the BC model along with the measures adopted by banks for ensuring the viability and sustainability of individual BC agents.
As we look towards the future, greater emphasis on improved digital literacy, capacity to use technology and a user-centric approach to the design of financial products and services will be the key determinants of the next wave of financial inclusion efforts. Innovations in technology and the increasing penetration of mobile phones too will provide greater impetus to address the inequities of exclusion and help achieve the very basic tenets of financial inclusion – access, usability, and affordability. At its very core, the ambition of our efforts must match the scale of the challenge before us.